For most car buyers, the look, smell, and feel of a new vehicle—even if it’s just new to you—is exhilarating. But before getting caught up in the excitement of your next vehicle, it’s important to understand how much car you can truly afford. No one wants to be in over their head financially, no matter how nice that new ride may be!
Determining what you can spend on a monthly basis for your new vehicle takes some work up front. Start by evaluating your cash flow, then calculate your potential auto loan payment. If you’re not sure how big your monthly payment can be without putting a strain on your wallet, we have some rules that can help.
Read on to discover handy guidelines you can follow to make sure your next vehicle purchase is a great fit for you and your budget.
The 20% Rule for Staying in Budget When Car Shopping
“Affordability” means something different to every car buyer, but there are some general rules of thumb that are helpful when deciding how much you can spend on your next car purchase. For example, the 20% rule suggests that you should spend no more than 20% of your take-home pay on all things car-related.
In other words, if you have a monthly paycheck totaling $3,500, your car expenses should be no more than $700 per month. Now, that may seem like a hefty amount for a car payment, but remember that your new auto loan won’t be the only car expense you need to consider.
Additional car ownership expenses include fuel costs, maintenance, insurance, and licensing and registration fees. (Check out this recent guide for helpful hints on calculating those expenses.) Once you take those extra costs into account, you’re ready to determine what you can afford for the monthly loan payment, which will be based on your credit history, the value of your trade-in, and the cost of the vehicle you want.
In the end, simply remember that your total car-related expenses shouldn’t exceed 20% of your monthly income, and you’ll be ready to find a car that’s perfect for you and your budget.
The 10% Rule for Buying a Car in Budget
While the 20% rule is a great guideline for total car expenses, you may be looking for more guidance on what you can afford for just your monthly car loan payment. In that case, financial experts suggest following the 10% rule for buying a car in budget.
Taking the example from above, if you earn $3,500 take-home pay each month, then your monthly car payment should be no more than $350, which is 10% of your paycheck. The idea behind this guideline is that if you only spend 10% of your income on your monthly car loan obligation, then you’ll have wiggle room in the budget for unexpected expenses or changes in circumstance over the life of your loan.
On the other hand, if you end up not needing this safety net for unexpected expenses, you can always put that money toward other needs or wants rather than having just enough to cover your loan each month.
Finding a Car You Can Afford with the 20/4/10 Rule
There is one final guideline that can help you find a car you can afford, and it’s known as the 20/4/10 rule. According to this rule, buyers should contribute at least 20% as a down payment, finance for no longer than four years, and take on a monthly payment no larger than 10% of their take-home pay.
Putting down a larger amount at the time of purchase benefits you in several ways—from lowering the monthly loan payment to ensuring there is never a time where the vehicle is worth less than what you owe on the loan.
The four-year loan guideline also helps safeguard you from going “upside down” on a loan and reduces the total amount of interest paid over the life of the loan. Finally, designating 10% of your take-home pay for the monthly payment will help keep you in budget for the long-term.
Setting a New Car Budget That Works for You
While the 20% rule, 10% rule, and 20/4/10 rule are all helpful guidelines in determining how much car you can really afford, they are simply suggestions. These rules provide a great starting point for setting a budget, but there’s always room for flexibility as you decide what budget really works for you.
If you find yourself wanting to increase your car expense budget to get the vehicle you want, consider whether you could scale back on spending in other categories throughout the month—just make sure you’re truly committed to scaling back! In the end, a happy car owner is one with a monthly payment he or she can afford, so set a car budget that works for you, then stick with it as you search for the perfect ride.